China Aircraft Leasing Group (CALC) is in the businesses of long-term direct aircraft purchase and lease transactions and long-term aircraft sale and leaseback transactions, primarily with leading airline operators in China. Basically, CALC offers aircraft leases to airlines that prefer to lease planes instead of incurring large borrowings on their balance sheet to purchase their own planes. In turn, CALC obtains long term bank borrowings to finance the purchase of these planes. The recurring cash inflows of lease income from its airlines customers are utilised to service CALC's bank borrowings. CALC earns the spread between its bank borrowing costs and that of the lease income. As we will see further on, this is a very lucrative business model. Besides, it also provides airlines with value-adding services, such as trading and re-marketing of used aircraft.

As at June 2018, the company has an aircraft fleet of 115 planes and the bulk of its customers are Chinese airlines. The company has a large backlog of orders for more than 200 planes from Airbus and Boeing that will be delivered in various stages until 2023. This translates into a fleet of over 300 planes by 2023, providing very strong visibility for the company's outlook. It should be pointed out that the company also engages in the sale of its aircraft leases periodically. This essentially means that instead of collecting the lease income stream patiently until the end of the lease tenure, the company opts to sell the lease to institutional investors. The nature of this transaction is complex, but it usually results in the company realizing an upfront profit and return of capital in exchange for the stream of future lease income.

Rise of the world's largest middle class. Air traffic in China has been growing relentlessly as strong GDP growth has translated into robust demand growth for air travel. Even if economic growth slows down in China as the traditional growth drivers of manufacturing and construction sputters, air travel growth is unlikely to slow down. This is because as China transitions from a middle to a high income economy, this will naturally lead to the development of an increasingly complex tertiary (service) sector as well as rising disposable income. An the estimate by McKinsey points to a sizeable upper middle class in China 2022, which has been the driving trend behind this explosive demand for air travel. A combination of rising income levels as well as increasing complexity of the tertiary (service) sector of the economy results in a surge of air travel.

CALC's fleet size has been expanding steadily on the back of the rapid explosion of air travel in China. In 2017 and 2018, CALC has accumulated a sizeable backlog of orders, ensuring the strong growth will accelerate in the coming years. Based on the order backlog, CALC is expected to triple its fleet size by 2023, from 2018 levels.

The rapid expansion of CALC's fleet size has translated into an even more rapid growth of its revenue and profits. This trend is expected to be sustained in the coming years given the sizeable order backlog. However, it should be noted that CALC is a recipient of government subsidies, which accounted for a third of CALC's 2017 profits. The subsidies are given as part of the government's initiative to promote the development of China's airline industry. Nevertheless, subsidies peaked in 2016 at HKD 261 million, and have been declining as a percentage of profits since 2015. While accounting for 2/3 of net profit in 2015, subsidies declined to 1/4 of net profit by 2017 and we can expect this figure to become less significant as CALC's underlying revenue and operating profit growth continues to rise rapidly.

(07-02-2019, 10:52 PM)realityinversion Wrote: China Aircraft Leasing Group (CALC) is in the businesses of long-term direct aircraft purchase and lease transactions and long-term aircraft sale and leaseback transactions, primarily with leading airline operators in China. Basically, CALC offers aircraft leases to airlines that prefer to lease planes instead of incurring large borrowings on their balance sheet to purchase their own planes. In turn, CALC obtains long term bank borrowings to finance the purchase of these planes. The recurring cash inflows of lease income from its airlines customers are utilised to service CALC's bank borrowings. CALC earns the spread between its bank borrowing costs and that of the lease income. As we will see further on, this is a very lucrative business model. Besides, it also provides airlines with value-adding services, such as trading and re-marketing of used aircraft.

An interesting business model, to say the least. It operates more as an unregulated bank than an airplane company. I have some questions.

1) With regards to the sale of leases to other investors - CALC is acting as a securitisation firm while keeping the liabilities on their own books. Does the sale of these leases cover their equivalent loan in full, or only a fraction of the total loan?

2) And more importantly, under what circumstances would CALC fail? What CALC is doing in effect is pooling together all the leverage and gains of the airline industry onto itself. If it fails, it fails spectacularly. Its operating lease income of $1,826 million HKD is 50% higher than interest expense of $1,241 million HKD. This means either a 33% drop in operating lease income through default or bad industry conditions, or a interest rate increase in the macroeconomic environment of 50%, would make CALC unprofitable as long as these conditions persist. There's also the double whammy that if CALC becomes unprofitable its refinancing terms would rise. I'm already surprised that such a leveraged company - 9x debt to equity and interest coverage of 1.5x from earnings can get an unsecured loan at ~5%. It has stated that is has swaps and hedges for the interest rates and that it will try to pass on increased interest rates to customers. Do you have any stress testing numbers?

I would also strongly disagree with the point that the planes could be resold easily. Under bad airline conditions plane prices will drop and CALC will take writedowns to its inventories.